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Last week Sheila Bair’s term as FDIC Chairman came to an end. When she began her five year term in mid-2006, home prices were at their peak and the banking system was logging record profits. Most analysts praise the performance of Bair as FDIC Chair, but like the other regulators, Paulson/Geithner at Treasury and Bernanke at the Fed, she did not see the pressures building in the banking system.

In mid-2006, Sheila Bair inherited a banking system that was at its peak in profitability. The FDIC Quarterly Banking Profile for the second quarter on 2006 showed that the banking system generated record earnings of $38.1 billion for the quarter. Industry data showed that the banking system added over $1 trillion in assets year over year, which proved to be a double-edged sword. While great for earnings, it should have been a warning that overleveraging was going to be a problem.

As Bair began her reign, our banking regulators were in the midst of forming regulatory guidelines with regard to exposures to commercial real estate loans, including construction and development loans.

I began to study the housing market and banking system in mid-2005 when I correctly predicted the bear market for homebuilder stocks - they peaked in July 2005. I began to study the FDIC Quarter Banking Profiles in March 2006, and began to write columns covering community and regional banks in April 2006 as a RealMoney.com Contributor:

  • April 28, 2006 – I was aware of the regulatory guidelines being considered by the three major banking regulators and wrote, “FDIC Red Cards Regional Banks” – The red-hot real estate market has fueled tremendous growth for community banks across the country, but this trend appears ready to turn, and they could be left with portfolios riddled with bad real estate loans. With shares of many trading at or near all time highs, the prudent investor should book profits now. During this time frame CNBC reported that several brokerage firms raised their ratings on regional banks.
  • June 1, 2006 – “Deal or No Deal, Cut Back on Merging Banks” – The housing boom of the past three years is starting to press the balance sheets of the financial organizations that underwrite construction lending and multifamily and commercial real estate lending. One of the mergers I talked above was Wachovia’s takeover of Golden West Financial.
  • June 5, 2006 – “Cash Out of These Regional Banks” - Regional banks are overexposed to real estate, judging by key FDIC ratios. I believe that as the real estate market slows more dramatically, these banks will suffer disproportionately from defaults among local builders.
  • June 14, 2006 – “A Landslide Could Bring Down Banks” – While the massive size and diversification of the biggest US banks have kept their FDIC ratios well below red lines indicating overexposure to real estate, the extent of their underwriting in construction lending and multifamily and commercial real estate lending is a matter of concern. Among the banks I was concerned about included; Bank of America (BAC), BB&T (BBT), Citigroup (C), JP Morgan (JPM), SunTrust (STI), Wachovia, Wells Fargo WFC) and Washington Mutual.
  • June 29, 2006 – “Regional Banks on the Fault Line” – Regional banks are dancing on the edge. Investors need to make sure they don’t fall into the crevasse, should those stocks stumble. I was worried about the pending rate hike by Bernanke to 5.25%. This overly aggressive interest rate policy threatens what has been the backbone of US economic growth since 2001, the real estate boom. I listed 50 banks in what I called “The Domino List.”
  • July 18, 2006 – “Don’t Bet on the Top Eight Banks” – Many Wall Street strategists view the huge banks as safe investment plays during risky and volatile times such as we have today. Community banks peaked at the end of 2006 and regional banks peaked in February 2007.

The Regulatory Guidelines for C&D and CRE Loans were formalized in December 2006

  • Overexposure to construction and development loans: The first guideline states that if loans for construction, land development, and other land are 100% or more of total risk capital, the institution is considered to have loans concentrations above prudent risk levels, and should have heightened risk management practices.
  • Overexposure to construction and development loans including loans secured by multifamily and commercial properties: If loans for construction, land development, and other land, and loans secured by multifamily and commercial property are 300% or more of total risk capital, the institution would also be considered to have a CRE concentrations above prudent levels, and should employ heightened risk management practices.

If FDIC Chair Sheila Bair followed these guidelines the FDIC would have started to close overexposed banks in 2007. Instead, there will be additional bank failure right through 2012.

The Sheila Bair FDIC Scorecard:

Q2 2006

Q1 2011

Change

% Change

Number of Banks

8,778

7,574

-1,204

-13.7%

Total assets

11,523,517,000

13,414,655,000

1,891,138,000

16.4%

1 - 4 Family residential mortgages

2,155,859,000

1,833,798,000

-322,061,000

-14.9%

Nonfarm nonresidential

859,410,000

1,064,489,000

205,079,000

23.9%

Construction and development

513,883,000

295,511,000

-218,372,000

-42.5%

Home equity loans

555,996,000

623,994,000

67,998,000

12.2%

Total real estate loans

4,085,148,000

3,817,792,000

-267,356,000

-6.5%

Other real estate owned

5,217,000

52,376,000

47,159,000

903.9%

Notional amount of derivatives

120,205,341,000

246,083,864,000

125,878,523,000

104.7%

Courtesy of the FDIC

  • The number of FDIC-insured financial institutions decline by 1204 banks through failures and consolidations.
  • The Total Assets in the banking system rose 16.4% to $13.4 trillion when deleveraging was the theme.
  • 1-4 Family residential mortgages decline by 14.9% as Americans lost their homes.
  • The FDIC allowed Nonfarm, nonresidential real estate loans to grow by 23.9% to $1.83 trillion despite the regulatory guidelines.
  • The banking system had to absorb a decline of 42.5% in C&D loans.
  • Home equity loans rose by 12.2% to $624 billion.
  • Other real estate owned (OREO) increased nine fold to $52.4 billion.
  • Where’s the required deleveraging as the notional amount of derivatives more than doubled to $246.1 trillion.

We are still dealing with the failures of Treasury Secretary Geithner and Fed Chairman Bernanke.

Source: The Financial Sector: A Look at Sheila Bair's Term as FDIC Chairman